Post Brexit WorldBy on 2016 Jul 1 Fri 13:18
As of this time on Friday, S&P500 has repaired all its losses after Brexit. Yet, British Pound is trading near the post Brexit low which is some 12% lower while Euro has repaired half of its losses. The volatility index (VIX) has its steepest decline within a week over the past 20 years. What is the world telling us?
The New Norm
First thing we should understand and accept completely is that such wild market environment is the new norm.
When trillions of dollars are on the line every second, central banks, large institutions and many other parties affected by major geopolitical events are all using derivatives and bots to manage their positions in real-time. When everyone reacts in a similar way, volatility spikes up quickly. This means a corrective move that used to take 3 months back in 1980s to complete will take only an hour as we have witnessed from what happened to Emini S&P.
Second, central banks play a far more active role than most people think.
As many smaller central banks are actively investing in non-traditional “safe” financial assets like stock markets around the world, their actions control the short term direction of the stock markets much more than most people realize. Similar to what happen back in the 1980s and 1990s for which the major investment banks move the markets the way they like to, even though they never admitted to that. The ability to absorb all the liquidity at critical price levels in various financial markets can generate a lot of profit. Be ready for more and more of these central banks will try to make money this way.
Third, the unintended consequences are unpredictable.
Those people put in charge of these central bank trading groups are no genius. They just have access to more information but that does not translate into making sound decisions, especially in the long run. The more speculative these central banks become, the messier the financial markets will become. It is exactly the type of environment we do not want to see again from the 1980s where greed dominated the Wall Street and yet, we are dealing with the same all over again.
Hence, there is no point to guess what will happen in 6 months or a year. This is the fatal mistake that the major hedge funds are suffering at this point. With their out-dated paradigm, the net effects of certain development in politics, economies and fundamentals within companies can be predicted. But the problem is that when the speed of information has approached instantaneous access to almost all market participants and normal people, such net effects no longer unfold in synchronization.
For example, even if we know that Brexit is going to cause economic slow down in Britain and that the longer term effect is going to be good for Britain relatively to European Union, the expected outcomes no longer unfold together slowly. The markets now discount the British Pound first, instantly reduced the valuation of the UK companies which in turn making those who like to position themselves to short the UK companies for the expected economic weaknesses facing a huge currency risk.
Where are the Trading Opportunities
Does this imply it is no longer possible to trade profitably in this environment? Of course not.
The best trading opportunities now are the moves generated by the mistakes of these biggest hedge funds. As they continue to use their old paradigm to make their trading decisions, they will continue to create pockets of price discrepancies that can be exploited effectively with short term trading. My Special Theory on Price Discovery (STOPD) outshines everything out there including techniques like market profiles or other more esoteric concepts in the current volatile trading environment, proving that there is a beautiful structure behind this seemingly chaotic world.
Happy Canada Day!